How 70% of Property Investors Lose Money

We never thought it would happen.

But it has.

Although we still can’t believe it.

We never thought we would put the words “good article” and “Michael Pascoe” in the same sentence. Never.

It was something that we expected to go to our grave never having written.

But yesterday Mr. Pascoe surprised us with “Housing bubble trouble for the middle class”.

So here we go, it was a good article by Michael Pascoe… [shudder!]

Mr. Pascoe even links to one of his terrible articles that he wrote on the 18th July, “RBA myth busters explode debt headlines”. We’re yet to come across a more sycophantic and embarrassing analysis of an RBA speech than that effort.

But hats off to him for linking to it because it shows how flimsy the RBA argument is when it comes to the housing bubble.

So what can explain Pascoe’s sudden about face on housing? Is it the urge to provide a balanced view? Or is it just the old tactic of having one bearish housing article to say, “I told you so” after the market crashes?

We don’t know for sure. That’s why we’re asking.

But anyway, we won’t give Pascoe too much praise for his latest article. Because out of the 1,064 words in the article for The Age, only 455 of them were Michael’s… that’s a shame.

The rest of the article directly quotes from a research report put out by Morgan Stanley’s Gerard Minack.

According to Minack as quoted by Pascoe:

“There is no value to society from rising house prices. It is simply a wealth transfer to existing owners from potential buyers. Pumping up house prices creates no more wealth than the RBA printing an extra six zeros on every piece of currency.

“Worse, by increasing the leverage in the household sector and financial system, it increases the financial risks in the economy, as the last two years have demonstrated elsewhere.”

I’d say that’s the key comment from Minack. Much of the rest pretty much confirms what we’ve written over the last couple of years.

There is no benefit to rising house prices. Housing is an expense. It’s a cost. It doesn’t produce anything. Housing is completely unproductive.

Its basic purpose is to provide shelter. Once the size of a house exceeds what is necessary for shelter then it is a wasted resource.

Even all the jobs that are supposedly supported by a buoyant housing market are a wasted resource. They could be better deployed elsewhere producing items that are beneficial to the economy rather than an expense.

But the pumping up of house prices can’t last.

At some point property investors will figure out they’re losing money due to rental income being below the cost of keeping the property.

Right now investors are prepared to suffer because they’re still falling for the fallacy that house prices always go up. Although I’m sure there are those that have figured out that the game is up and so they’ve been trying to get out while they can.

But make no mistake, just like every other asset bubble at some point sellers will look to leapfrog over each other in their rush to sell.

That’s when the bubble pops.

But we will disagree with Minack on one point, it’s this:

“If Australia could achieve a cycle where house prices are steady or see moderate nominal declines, while growing incomes at a trend 6 per cent growth rate, it could reduce the over-valuation and financial risks associated with excess debt.”

According to another article in The Age, “Total pay rose 4 per cent over the 12 months to August 2010…” That’s a fair shake of the sauce bottle below the 6% Minack mentions.

The fact is, it’s the very slowing of the housing market and the so-called flattening of house prices that will ultimately cause the crash. Property investors are in the game for capital growth and nothing else.

As you know, where possible we like to get our hands on these reports rather than rely on the filtered nonsense you get from the mainstream press. So, not having Gerard Minack’s contact details instead we got in touch with our old pal Professor Steve Keen to see if he could help out.

Quick as a flash the Prof got back to your editor with the report. In it, Minack produces a couple of interesting charts to prove the case about how much landlords rely on capital growth rather than income.

However, as of this minute we haven’t yet received permission from Mr. Minack to reproduce those charts. When – or if – we do then I’ll show them to you. Until then you’ll just have to take your editor’s word for what they show…

The first shows a staggering 70% of landlords claim a rental loss:

Unfortunately I can’t show you the chart yet, but you can see some of the stats from the Australian Taxation Office (ATO) by clicking here…

If you start at page 17 you’ll see that at every income level bar one there is a net rent loss. The exception being those on a taxable income of $6,001 to $10,000 where there is a positive rental income.

All up, based on the 2008-2008 tax year there was $12.7 billion of rental losses with only $4.1 billion of rental profits. That leaves a net loss of $8.6 billion.

In other words, the rent received is less than the cost of operating the rental property.

And the second chart shows exactly how that happens:

Again, I can’t show you that yet, but click here, scroll down to page 17 and you’ll get the raw figures from the ATO. We’ll see if we can chuck this info in a chart for you tomorrow.

But what it shows is gross rent, less costs, less interest equals a massive bubble producing net rent deficit.

Rental properties are a bad investment alright. We couldn’t agree more. Just look at how steep the red “net rent” line has moved in recent years. Property investors are by now losing $10 billion a year.

Those two charts alone should be enough to convince anyone that property is set to collapse. That consistently running a loss making investment just isn’t sustainable. And that’s why we’re prepared to say that the housing market won’t be able to achieve any such “moderate” decline in house prices at all.

You see, moderate declines tend not to happen when the game is up on any over-extended market. Hoping for a moderate decline is like suggesting all share investors gang together and agree never to sell their shares – “If nobody sells we’ll all stay rich and everyone else will miss out”

As you and I know, that just isn’t possible.

The bubble is a result of a manipulated market. And like any bubble it becomes unsustainable and bursts. Regardless of the attempts to manipulate a soft landing.

Is it likely the same crowd that rushed in to buying property would calmly and coolly exit the market? We wouldn’t have thought so. They’ve rushed in thinking they can make an easy buck and sure enough they’ll rush back out again when they face up to their mistake.

The fact is, you can have as many charts and statistics as you like giving reasons for house prices never falling, but what it comes down to is human action and reaction.

For instance, we vaguely recall a study into airline evacuation procedures a few years back. As part of the study, when participants were asked to exit the plane at the nearest exit they did so in a reasonably orderly fashion.

Remember, it wasn’t a real emergency so the passengers knew they weren’t in any danger.

However, when a financial incentive was provided to some of the participants providing they were one of the first to exit the plane, then all bets were off. Those that had the financial incentive to get out quicker naturally tried to push their way past others in order to get out first and claim their prize.

Those that didn’t know about the financial incentive were naturally confused and also tried to get out quicker even though there was no real danger and no financial reward for them to do so.

What I’m saying is, in that test the financial reward was minimal, about $20 we think. In the case of the housing , the penalty for not getting out will be huge. Can we really expect the exit to be orderly? “No, I insist, you sell your house to this willing buyer first. I’ll wait for the next willing buyer to come along. I’m sure it’ll only be a few months…”

Of course not. The charge for the exits will be just as vicious as the crashes you see in the stock market.

If you’ve been reading Money Morning for some time you’ll know that we like the idea that property investors could be the ones to kick off the housing slump.

Minack’s analysis shows just how rotten property investing is right now.

But think about it this way. One of the claims made by the spruikers about the difference between the Australian housing market and the US housing market is that mortgages in America are tax deductible for owner-occupiers whereas they aren’t for Australian owner-occupiers.

Therefore – so the argument goes – there was little incentive for borrowers in the US to pay down their mortgage debt, especially when house prices continued to rise. Simply because they could deduct the mortgage repayments from their income, plus they could withdraw equity in their high valued home.

Granted. We’ll accept that.

But now let’s think of it this way. Who does qualify for tax deductibility of housing mortgages in Australia? That’s right, property investors.

So, by the same token, if it’s argued that there is little incentive for American owner-occupiers to pay down housing debt, then surely it’s also the case that there’s little incentive for Australian property investors to pay down their housing debt.

Again, Minack’s numbers prove this. 70% of landlords receive a negative rental income from their properties.

Although we’re sure the spruikers will still try and claim that somehow Australia is different on that score as well.

But don’t forget about the way property investing works. You’re not just talking one investor with one property. The game of property investing is to continue leveraging up, to buy one, wait for the price to rise and then use the so-called equity as the down-payment for the next leveraged property.

The whole mucky scheme involves going ever further into debt. The greater the debt the bigger the tax deduction. Just ask 70% of Australia’s 1.7 million landlords how it all works. They’ll tell you…

“It’s all tax deductible mate…”

Cheers.
Kris Sayce
For Money Morning Australia

Tagged as: bubble, buyer, housing, invest, market, money, price, property